Money Supply in India: Concepts, Measures and Determinants

Meaning of Money Supply

Money supply refers to the total stock of money available in an economy at a given point of time.

It includes currency held by the public and deposits held with banks.

Money supply influences inflation, investment, credit creation and economic growth.

Components of Money Supply

Money in modern economy exists in two main forms.

Currency held by public, which includes notes and coins issued by RBI.

Deposits held with commercial banks, which can be withdrawn or used for transactions.

Measures of Money Supply in India

The Reserve Bank of India classifies money supply into four categories: M1, M2, M3 and M4.

M1 (Narrow Money)

M1 includes currency with the public, demand deposits with banks and other deposits with RBI.

Demand deposits are deposits that can be withdrawn anytime, such as savings and current accounts.

M1 is called narrow money because it includes highly liquid forms of money.

M2

M2 includes M1 plus savings deposits with post office savings banks.

It is slightly broader than M1.

M3 (Broad Money)

M3 includes M1 plus time deposits with banks.

Time deposits are fixed deposits that cannot be withdrawn immediately without penalty.

M3 is the most commonly used measure of money supply in India.

It is also used for policy analysis.

M4

M4 includes M3 plus all deposits with post office savings banks.

It is the broadest measure.

Important Prelims Concepts

Currency with public does not include cash held by banks.

Demand deposits are part of M1.

Time deposits are part of M3.

M3 is called broad money.

Determinants of Money Supply

Money supply depends on:

Monetary base or high-powered money.

Credit creation by commercial banks.

Reserve requirements such as CRR.

Public’s preference for holding cash versus deposits.

High-Powered Money (Reserve Money)

High-powered money refers to currency issued by RBI plus reserves held by banks with RBI.

It is also called reserve money or base money.

It forms the foundation for credit creation in the economy.

Money Multiplier

Money multiplier shows how initial increase in base money leads to larger increase in total money supply.

It depends on reserve ratio and public’s cash holding behavior.

Lower reserve ratio leads to higher money multiplier.

Credit Creation by Banks

Commercial banks create money through lending.

When banks give loans, they create deposits, increasing money supply.

However, credit creation is limited by CRR, SLR and demand for credit.

Money Supply and Inflation

Excess growth in money supply relative to real output can cause demand-pull inflation.

However, in India, inflation is often influenced by supply constraints as well.

Mains Analytical Angles

Money supply growth must align with economic growth.

Uncontrolled monetary expansion can destabilize economy.

Coordination between monetary policy and fiscal policy is essential.

Transmission efficiency determines impact on real economy.